Time-varying correlations and interrelations: Firm-level-based sector evidence

Citation

Evans P, McMillan D & McMillan F (2017) Time-varying correlations and interrelations: Firm-level-based sector evidence. Journal of Asset Management, 18 (3), pp. 209-221. https://doi.org/10.1057/s41260-016-0034-3

Abstract
Using firm-level data, we examine stock market correlations and interrelations for the G7 over the period 2000–2013. An examination using aggregate market data supports the view that correlations have risen and particularly so during crisis periods. Using firm-level data, which is tradeable, we establish sector portfolios. We consider three regression approaches. The results support, first, that correlations using firm data are lower than those observed using aggregate market index data. Second, the most important driver for home sector returns is the home market followed by the corresponding US sector. Third, correlations rose during the crisis but have stabilised and even fallen since. This supports the view that markets fall together but rise apart. Fourth, there is evidence that most sector correlations follow a market-wide component, but some sector correlations follow their own component. Subsequently, we examine the key drivers of time-varying correlations. We find that the market-wide component of correlations increases in a US bear market as well as with higher US market volatility and lower US interest rates. However, on a sector basis, there are notable exceptions with some correlations falling in a bear market. Together, these results support the view that diversification benefits remain across market sectors.

Keywords
stock markets; correlations; firm-level; sectors; time-varying

Journal
Journal of Asset Management: Volume 18, Issue 3

People

Professor David McMillan

Professor in Finance, Accounting & Finance